Focusing on Contract Structure Rather than Guarantees

I actually wrote something on guaranteed contracts in the NFL recently but I’m going to hold off on publishing that until tomorrow or Monday and instead look first at contract structure. What really brought this post on was an interesting tweet by Jason Cole of Bleacher Report

In a later post Cole referred to the failures of the 2015 free agent class and how many have already been released as support for his argument. We had looked at the 2016 group just the other day and saw how many are likely fighting for jobs on 2017.  All that being said I don’t understand why this is an issue or an argument by agents. Its something that they have the power to stop but have failed to do and let get out of their control to the point where actual earnings are probably impacted.

In the earlier days of the salary cap era it was more or less considered reasonable for contracts to be benchmarked in three ways- the average of the contract, the signing bonus, and the three year value of the contract, with the three year being considered the most important metric. The three year is something we track in our premium section and often members of the media are given that information as a way to report on a contract.

The three year metric became an important benchmark because most studies at the time agreed that most long term contracts that were signed in free agency were going to see the player paid for a minimum of three years. While it wasn’t guaranteed to be earned most likely if a five year contract was signed the player was going to see 3 years of the deal unless they were an epic failure like a Shaun Alexander who fell off the cliff the minute he signed a contract.

The reason behind this really wasn’t because teams were more generous to veterans (though coaches did rely more on them than they do now) and less cutthroat in the front office. This had much more to do with contract structure and salary cap ramifications in some cases binding teams to players for a longer period.

In general contracts in the past only contained one guarantee- a large signing bonus on the front end of the contract. The signing bonus is prorated over the term of the contract (its now limited to five years rather than six) and would accelerate onto the cap when the player is released, the term commonly referred to as “dead money”.  To fit the player’s contract within the salary cap base salaries were more often than not lower on the front end.

I’ve long since considered the signing bonus (or any form of prorated money) an insurance policy on the contract. When the cost to release becomes prohibitive teams generally will bite the bullet on the player and let him play out an added year on the contract, especially since his third year salary was likely low relative to the contract value.

When contracts are signed I often benchmark them via cash flows and cap structure and determine what I consider the virtual guarantee on the contract. If you look back on some of my original postings at OTC when it first began you can probably find a few articles on that in the 2013 and 2014 seasons and its something I talked about in my book as well. The virtual guarantee looks at the contract structure and helps estimate what the player should earn unless his play falls so far off a cliff that the team has no choice but to move on. In recent years I have done this less and less because changes in contract structure have made it less likely that the virtual guarantee is any different than the basic contractual guarantee except in the case of certain teams.

At some point this basic structure changed in the NFL as agents began to focus on “guaranteed” salary rather than creating a contract structure that insulated the player from early termination on his contract and maximized his potential earnings better. I would think this actually started with rookie contracts probably sometime around the 2006 or 2007 seasons when the top rookie guarantees and early salaries began to exceed by a pretty wide margin some of the upfront in the veteran salaries. The contract guarantee definitely became a big buzzword by the time the Stafford’s and Bradford’s of the world signed contracts and things shifted after the new CBA was agreed upon in 2011.

Whenever a team and a player sign a contract a certain level of risk is assumed by both parties. When a team guarantees salary they are absorbing the risk in the event the player flops, is hurt, etc… Teams are going to (or at least should) ask players to give up upside value since they are taking on the risk. For example a team may be willing to pay $10 million to a player in a given contract year but if they need to guarantee it they will only go to $7.5 million. That’s beneficial to a team because the team more or less knows when they sign the contract what they expect the real contract to be. So they may know full well that they expect the player to only be around for two or three years of a five year contract. By focusing on the guarantee the team has now reduced the APY of the contract by $500,000 and more importantly saved themselves $2.5 million in real money by making it seem as if the guarantee was a major concession on their part. The team knows that if the goal is a giant guarantee you can bank on the player opting for the “guaranteed” salary rather than the higher salary that was probably, in the past, 90-95% likely of being earned just based on the contract structure alone.

The Tampa Bay Buccaneers began a new team-wide philosophy around 2011 in which they refused to pay signing bonuses for any players other than draft picks, whose bonuses were more or less mandated by the CBA.  In return the Buccaneers would “guarantee” the first two years of a contract, which would generally be a very large guarantee, in my opinion exceeding what would be earned in a normal contract structure, but feature favorable cash payouts for the team and eliminate the risk of dead money.

But this posed significant risks for players. For one with no signing bonus there was absolutely no accounting reason for the Buccaneers to consider holding onto a player once his salary guarantee was paid out. There was no consideration to what would make more sense from a cap standpoint such as holding onto a player with a $5 million salary with an $8 million cap hit or cutting him and taking on $9 million as dead money.

In addition salary guarantees are usually contingent on a player not failing a drug test, being suspended by the team for conduct, and so on…If the player gets hit for anything he can potentially lose his salary guarantee for the whole season, such as Doug Martin’s $7 million salary. If money was instead paid as a bonus they can only lose 1/17th of the prorated amount for each week suspended and the rest of the bonus is theirs to keep when cut.

While the Bucs have not been the most successful team in the NFL they have constantly been able to churn their roster in part because of these contracts. Their model has been followed by the Raiders, Jaguars and more recently the Colts but more and more teams are following basics set forth by the Bucs by lowering signing bonuses and guaranteeing large amounts of P5 salaries in the first two contract years giving teams more and more flexibility to release players. The Eagles have gone a step further often throwing in a small guarantee for an additional season knowing full well they will recover that money when the player is released if he signs with another team due to offset clauses. Remember signing bonuses are the players to keep when cut.

The focus on the guaranteed salary has extended further into the undrafted free agent crop. The NFL limits the signing bonuses that can be given to teams so teams instead have begun offering guaranteed salary to the UDFA’s instead of a signing bonus. Because these guarantees contain offsets there is far less value in these guarantees than the signing bonus. Certainly a $20,000 guarantee is nothing to sneeze at for a UDFA, but if the player lands on a practice squad for three weeks or the active roster for a week during the course of the year that guarantee is now offset. Had he received a $10,000 signing bonus he would earn both the bonus and the $20,000 when he made the PS or the 53 man. More risk for the player, sure, but in most cases the player would have earned more money opting to take a lesser guarantee via a different mechanism.

I don’t think it is surprising that teams that still follow the relatively traditional contract basics like the Steelers and Bengals are the teams that seem to have players that more often than not come close to playing out their contracts and teams that use big bonuses and restructure deals like the Cowboys, Saints, and Bills often see players go long as well. But for teams like the Eagles, Bucs, Raiders, and so on who have featured more “guarantees” in lieu of contract structures that may provide more favorable those players are open game sooner rather than later.

Its probably somewhat ironic that the person who was responsible for the original tweet, Maclin, played on a relatively “old school”contract that paid him a $12 million signing bonus. Maclin’s release was helped out by some changes in the CBA that had good intentions but may have hurt the players overall which gave them the leeway to do it, but the topic itself I think is a very good one.

The union can probably help change this by demanding that the league institute mandatory salary cap spending limits and eliminate the LTBE loopholes to meet such requirements. Because carryover in the current CBA is so large teams have been able to increase their cap space to gigantic numbers each year and avoid ever being in cap trouble. This allows teams to follow the full cash philosophy and even if they didn’t be able to handle the dead money without a thought. If they refuse to change that then the June 1 rule needs to be eliminated as that would save a player like Maclin and in reality there is no place for the rule with the large salary cap surpluses being carried over if there are no cap spending limits.It would also be beneficial to reinstitute the 6 year proration rules to put more pressure on teams cap situations as players age and to also bring back more negotiating into the rookie contract process at the top of the draft. And no fully guaranteed contracts wont change anything (more on that in a later post) in the long run.

The question is can this be changed?  Agents have the power to try to bring the discussion back into structure, but it all begins at the top and unless you have big name players trying to maximize bonuses and virtual guarantees rather than actual guaranteed salary it wont change. For those players, who have made a killing in free agency and are getting three years worth of guarantees anyway they probably don’t have the incentive to do it either which makes it difficult for everyone else. But if the focus can change towards evaluating structure and likelihood of earnings rather than falling into a benchmark that in reality has little meaning slowly they can all bring about some change and move off the two year and back to the three year earnings metrics.

  • Werner

    Jason,
    excellent as usual.
    My takes: Contract structures started to change, once carryover becames a normal thing in the CBA and didn’t have to be affected via LTBE Trickery. There is now reward to cut/trade now and create carryover for tomorrow, where earlier the holding on phenomenon was stronger. Now there is also no more penalty, as you can balance out minimum spend over four years easily.
    Also, taking best practice from the Patriots, absorb costs to improve your Team, has become more obvious. And finally, almost no Team is in deep Cap Issues anymore, driven by the inflationary increase of the Cap Numbers, that neither Teams nor Agents predicted. This has allowed Teams on both sides of a trade to work with guaranteed P5 salary without pain.
    How to cure: What’s the incentive structure of the Agent ? How much does he see right away as a cut from a Signing Bonus vs the trickle of Cash Flow from Guarantees ? Are these Agent income structures synchronized with the best earning potential structure of the Clients ?

    • McGeorge

      The question is will the cap still go up so fast every year? What if it stops going up? Then some teams may be badly hurt, having to extend some players at high salaries, and having to cut other good players.

      • Werner

        That is indeed a relevant question, but the NFL lives for the now. Also of some influence will be the fact, that a (re)new(ed) CBA is already looming into 4th to 5th years of contracts now done. And even a Breakfast Club as is NFLPA should have taken note on need for action.

  • Ken Stauder

    When will the Matt Asiata/Lions contract be shown?

  • McGeorge

    Jason,
    Maybe I’m misunderstanding, but even if all teams adopted the Buss approach, and vets are cut left and right after 2 years, teams still have to pay out the salary cap floor based on a 5 year average, right? So if they cut vets, freeing up cap space, they have to spend that money on other players. So some vets are hurt, and others benefit. The players as a whole are still earning the same amount, just that its split among more players.